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On September 16, 1998, the Securities and Exchange Commission ("Commission")
requested public comment on a proposed rule change by the Chicago Board
Options Exchange, Inc. (the "CBOE") relating to floor brokerage subsidies.
Under Section 3(f) of the Exchange Act the Commission must consider
the impact on competition and efficiency of rules proposed by self regulatory
organizations, like the CBOE. 15 U.S.C. §78c(f).

The United States Department of Justice ("Department") respectfully
submits that the proposed rule change (the "Proposal") raises a number
of competitive issues that were not adequately addressed by the CBOE.
While the Department has not conducted an investigation of this matter,
the Department believes that the Commission should not approve this
Proposal until the CBOE has adequately explained why this rule will
not adversely effect competition and provided a fuller explanation of
how this rule will promote competition between exchanges.

II. The Proposal

The Proposal would allow CBOE "Resident Market Makers" in each class
of options to act jointly in setting and imposing a uniform fee on each
contract traded by any market maker in that options class. (Resident
Market Makers are those market makers who do 80% of their business in
that particular class of options.) The fee would apply to all
trades in that option, by any market maker. Market maker votes
would be weighed by market shares. The fee would be assessed on a per-contract
basis and would be used to create a fund to pay subsidies to commission
agents. The CBOE would collect the funds set by this joint assessment,
and would use them to pay subsidies to certain commission-earning business
units on the floor of the CBOE.

Specifically, Resident Market Makers would be able to vote to reduce
the commission charge for the Order Book Official ("OBO") who keeps
the public limit order book in the relevant class of options. The fees
on the market makers would then fund the difference between the CBOE's
standard OBO rate and the reduced OBO commission level. Any remaining
funds from the market maker fees would be used to subsidize certain
floor brokers who commit to doing most of their brokerage business in
the relevant class of options (known as "Stationary Floor Brokers").
These subsidies would apply on a per unit basis for the business done
by the selected floor brokers. All CBOE floor brokers are free to set
their commissions as they see fit, and will remain free to do so even
under the Proposal, but the Proposal anticipates that Stationary Floor
Brokers who receive the subsidies will reduce their commissions to off-floor
or retail brokers (who receive the original customer orders).

III. The Stated Rationale for the Proposal

The stated purpose of the Proposal is to enable the commission agents
to lower their commissions to the general public to meet competition
from options exchanges, such as the American Stock Exchange, which use
specialists rather than market makers to provide liquidity. On the specialist
exchanges, the specialist maintains a public limit order book. The specialist
may charge a commission for orders crossed from the book. The specialist
in each class of option sets the order book commission for that class
of option. The specialist may also trade as a principal for his own
account.

On the CBOE, the OBO keeps the limit order book as an employee of
the CBOE. The OBO charges a commission for crossing orders from the
book, but the OBO does not set the level of this commission. Instead,
the CBOE sets a uniform OBO commission rate applicable to all OBO business
on the CBOE floor. In addition, OBO's cannot trade as a principal.

The Proposal would give market makers the ability to subsidize the
OBO function, allowing market makers to lower OBO's effective commission
charges to off-floor or retail brokers. Specialists on the other exchanges
can already (internally) subsidize their order book commission business
with profits from trading. Thus, this Proposal would arguably allow
CBOE market makers to place the OBO function on an equal competitive
footing with the order book business of exchange specialists.

Insofar as the Proposal would allow the Resident Market Makers to
subsidize floor brokers who qualify as Stationary Floor Brokers, the
subsidy is apparently meant to overcome a disadvantage resulting from
the inability of floor brokers to subsidize their commission business
by trading as principals as specialists do. However, it is not clear
from the CBOE's explanation of the Proposal why the CBOE compares floor
brokers on the CBOE with specialists on the other exchanges. Floor brokers
exist on all options exchanges and currently, as we understand it, they
are not subsidized on any exchange. CBOE has not shown why subsidizing
CBOE floor brokers, when others are not, will promote competition.

IV. Competitive Issues Raised by the Proposal

As a general matter, CBOE market makers are competitors in buying
and selling options contracts with the public. Under the Proposal, the
market makers would be collectively setting fee and payment obligations
that could affect the prices paid by the public for their market maker
services. The CBOE should not be permitted to adopt a rule allowing
market makers to agree on matters that could affect prices the public
pays for securities and/or securities transactions without a compelling
justification.

The explanation and information provided by the CBOE in support of
its Proposal are inadequate. Under the Proposal, CBOE market makers
would pay the subsidies to the OBO and floor brokers from trading revenues
earned from the difference in bid and ask quotations. The Proposal,
therefore, may increase pressure on market makers to increase their
spreads in order to finance the subsidies. Wider spreads would result
in consumers buying and selling options at prices inferior to those
at which they could purchase options absent the Proposal. While any
adverse effect on securities prices might be offset by reduced commission
payments if floor brokers pass through their subsidies, a rule that
would allow competitors to create a subsidy that may increase one consumer
cost in order to reduce another needs more justification than the CBOE
has provided. At the very least, the CBOE should indicate why the Proposal
will not adversely affect spreads and/or net consumer cost.

The risk for an adverse effect from the Proposal would appear to be
greatest for small retail market orders that are executed automatically
without intervention by the OBO or a floor broker. These customers are
most likely to see their transaction costs increase, inasmuch as they
may not receive any benefit from lower floor broker commissions. The
Proposal may also give market makers the ability to affect the relative
costs of limit and market orders by giving market makers the power to
allocate the subsidy between the OBO and floor brokers. If market makers
acting under the Proposal were to discourage limit orders, limit order
discipline on market maker spreads may be reduced and spreads may widen.

In addition, there is no guarantee that the Proposal will reduce consumer
commission costs. Floor brokers are under no obligation to reduce their
commission rates. Moreover, if they do reduce their commission rates
to off-floor brokers, an off-floor broker may not reduce charges to
his or her customers and the customers would not benefit from the Proposal.
Further, the off-floor broker would have an incentive to route orders
to the CBOE because the commissions he or she pays to the CBOE floor
brokers or OBO's may be less than that charged by competing exchanges.
The result of the Proposal, then, would be the creation of a form of
"payment for order flow." Customers may be harmed if off-floor brokers
route their orders to CBOE because of the payments when they would receive
a better execution if routed elsewhere.

The voting mechanism by which market makers would establish the fee
also raises competitive issues. By weighing each Resident Market Maker's
vote by market share, the Proposal creates an opportunity for market
makers with substantial order flow to set fees that competing market
makers on the CBOE must also pay. The fees assessed could raise disproportionately
the total costs of smaller rivals, thereby disadvantaging them.

Finally, the CBOE's objectives may well be achievable through less
anticompetitive means. At a minimum, the CBOE should be required to
show that other non-collaborative methods could not achieve the same
ends.